Question

You are opening a landscaping business, and wish to estimate your levered cost of equity. Beatrice's Yard Maintenance has an equity beta of 1.2, and a D/E ration of 1.1. If the riskless rate is 0.05, the expected return on the S&P500 is 0.11, and your firm will have a D/E ratio of 1, what would your firm's levered cost of equity be if the tax rate is 0.23? Please give your answer in the form of a decimal to 2 places - if your answer is 10.5%, please enter 0.105.

Answer 1

Unlevered Beta (βA) =	Equity Beta (βE)
1 + (1 − t) × D/E

Equity Beta (β_E) of Beatrice's Yard Maintenance = 1.2

D/E ratio=1.1

t=0.23

Therefore,

Unlevered Beta (β_A)=1.2/(1+(1-0.23)*1.1)=0.65

Hence, Equity Beta (β_E) of Own Firm= Unlevered Beta (β_A) X [1 + (1 − t) × D/E]

=0.65*[1+(1-0.23)*1]=1.15

Cost Of Equity Of Own Firm According to CAPM= risk free return+beta(market return-risk free return)

=0.05+1.15(0.11-0.05)=0.119[Answer]